Morgan Stanley
  • Thoughts on the Market
  • Sep 14, 2020

Could the Correction Continue Further?

With Mike Wilson
U.S. Equities Research for Investors

Why gridlock on the next U.S stimulus package—combined with election year uncertainty—suggests there could be more downside in September and October.

Each week, Mike Wilson offers his perspective on the forces shaping the markets and how to separate the signal from the noise. Listen to his most recent episode and check out those of his colleagues from across Morgan Stanley Research.

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Current Episode Transcript

Welcome to Thoughts on the market. I'm Mike Wilson, Chief Investment Officer and Chief US Equity Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, September 14th, at 11:30 a.m. in New York. So let's get after it.

Over the past few weeks, we've finally experienced our first meaningful correction in U.S. equity markets since this new bull market began in March. More specifically, the S&P 500 is down about 7% from its recent all-time high, while the NASDAQ 100 is down about 11%. What should investors make of this correction and what should they do next?

First, we think this correction is just that, a correction in a new bull market. It's normal for markets to pullback after such an incredible run like we've experienced since March. Furthermore, when a new bull market coincides with a new economic cycle, the bull market usually runs for years, not months. Second, the correction is being led to the downside by the biggest winners, namely technology stocks and other beneficiaries of the COVID lockdown. This too is unsurprising, at least to me. This recession and recovery have been steep and sharp, representing what can only be described as "V-shaped" at this point. If one truly buys into this view, however, then it would make sense that stocks that benefit from the lockdown would be the most vulnerable in a correction.

The questions for investor to ask now are: 1) how much further will this correction go? And 2) what should they be looking to buy? On the correction, we think there's still downside as markets digest the risk of congressional gridlock on the next fiscal deal. While we think something will ultimately get done, it will likely take another few weeks to get it over the goal line, which should keep markets nervous in the short term. Importantly, once the deal passes, the risk will shift to higher long-term interest rates, which have been a major support to the rally so far, and the preference for large cap growth stocks. Finally, it's an election year and historically, U.S. equity markets have traded poorly in the months of September and October. Specifically, these months have been down about twice as often as they've been up, and the moves have been significant in many cases. With this year's election looking close, we expect uncertainty to remain high.

My experience with market corrections usually has me lean on technical analysis. On this front, it's easy to see that equity markets became very extended in August and well above key technical support levels. In fact, even after the recent correction, support levels remain well below the current price. More specifically, the 200-day moving average for the S&P 500 is still 7% lower, while its 15% lower for the NASDAQ. While there's no rule that says we have to visit these support levels in this particular correction, they are good to keep in mind should it resume after today's sharp bounce.

We remain focused on stocks and sectors that will exhibit the most operating leverage next year as the economy continues to reopen. This leads us to smaller capitalization stocks in the materials, industrials, financial, and consumer discretionary sectors. One area in particular to keep in mind is consumer services, things that you can't consume or experience today because that part of the economy remains effectively closed. Some examples include travel and leisure, restaurants, and building activities. Finally, I've been highlighting financials as the best way to participate in rising long term interest rates that should occur once we get through the congressional impasse on fiscal spending and the election is concluded. Bottom line, be patient and selective with new purchases over the next few weeks and months.

Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts App. It helps more people to find the show. 

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